Reserve Bank 'not considering' rates hikes

McDermott says inflationary pressure are expected to increase. Photo / NZ Herald

The Reserve Bank of New Zealand isn't considering an increase in interest rates at present and is watching for any signs of weakening demand and domestic inflationary pressures that could warrant a rate cut, says assistant governor John McDermott. The kiwi dollar shed almost half a US cent.

"Before considering any tightening in monetary policy we would need to be confident that increased capacity utilisation and labour market tightness was generating, or about to generate, a substantial increase in inflation," McDermott told a meeting of the Waikato Chamber of Commerce and Industry and Waikato branch of the Institute of Directors, in Hamilton. "Evidence of weakening demand and domestic inflationary pressures would prompt us to consider lowering interest rates."

McDermott's language is more dovish than that of governor Graeme Wheeler's views in the March 12 monetary policy statement, in which he said "future interest rate adjustments, either up or down, will depend on the emerging flow of economic data." Today, McDermott highlighted what he called "some areas of uncertainty surrounding the outlook for capacity pressures", including the lingering effects of drought, fiscal consolidation, lower dairy incomes and the impact of the exchange rate on export and import substitution industries.

"It just emphasises that if the Reserve Bank is going to be doing anything with the OCR this year, it's going to be cutting it, not increasing it," said ASB Bank chief economist Nick Tuffley. "What's going to drive a cut is evidence that accumulates over time that essentially inflation won't climb back that rapidly. The risks are pretty clearly biased downwards."

The kiwi recently traded at 75.93 US cents, having dipped as low as 75.83 cents, from 76.27 cents immediately before the speech was released.

"Beyond these factors, we are also assessing the outlook for tradables inflation that is being dampened by global conditions and the high exchange rate," he said. "The fact that the exchange rate has appreciated while our key export prices, such as dairy, have been falling, is unwelcome."

It just emphasises that if the Reserve Bank is going to be doing anything with the OCR this year, it's going to be cutting it, not increasing it.

ASB Bank chief economist Nick Tuffley

McDermott's speech is the second in as many weeks by senior central bank officials ahead of the April 30 review of the official cash rate. Deputy governor Grant Spencer urged the government to look again at the preferential tax on investment in housing and called for other local and central government measures that could address Auckland's over-heated housing market.

The bank is expected to keep the OCR at 3.5 per cent next week and some economists say it won't raise the rate until 2016, by which time inflationary pressures should be more evident.

McDermott's speech, entitled: "The dragon slain? Near-zero inflation in New Zealand" asks whether the dragon of inflation has been slain given annual inflation in the March quarter was just 0.1 per cent, largely driven by the weak price of crude oil.

"I do not believe so," he said. "The dragon is merely sleeping."

"Past declines in oil prices will reduce headline inflation substantially in 2015, but if there are no further falls, then this negative contribution will drop out of the annual inflation rate by the start of next year," he said. "Growth is currently underpinned by high net immigration, strong employment and construction activity, and robust household spending."

Read the full speech here: